The clause is a key part of the Bill, and it deserves considerable discussion by the Committee. I make no apologies for the fact that I shall be speaking at length on the clause. I have already explained why it is difficult to come up with amendments: so much is being left to further consultation, or to regulation or codes of practice later on.
The National Association of Pension Funds makes the same point. It says that
''most key issues (eg the way in which assets are valued; the determination of liabilities; etc) are to be set out in secondary legislation or in actuarial guidance.''
It makes the perfectly reasonable point that it wants
''to see an open and transparent process with proper consultation of interested parties.''
I do not think that anyone could disagree with that.
I shall begin by discussing the background, including the history of the MFR, because it will be useful to inform the debate. The MFR has had a fairly bad press recently but, as the Minister conceded earlier in a different context, it served its purpose, at least for some time. It is interesting to note what my right hon. Friend the Member for Richmond, Yorks (Mr.
''The MFR will provide members with a reasonable assurance that, should the sponsoring employer become insolvent, the scheme will be able to deliver the relevant accrued rights. If the scheme is at least 100 per cent. funded on the statutory basis, pensioners can expect their pensions to continue to be met in full, while younger scheme members will be entitled to a fair actuarial value of their rights which they can transfer to another scheme or to a personal pension.''—[Official Report, Standing Committee D, 23 May 1995; c. 355.]
In broad terms, the aim of the MFR test was to ensure that a scheme had sufficient funds to keep paying benefits for members whose benefits were already in payment and to pay minimum transfer values for other members. However, as has become painfully apparent since then, the fact that a scheme was 100 per cent. funded on the MFR basis would not necessarily indicate that there were sufficient assets to secure the accrued benefits on wind-up.
It is also worth remembering that, prior to the 1995 Act, if a company became insolvent, the pensions of those who had not retired were only partly protected: to the extent of the guaranteed minimum pension, given in place of the state earnings-related pension scheme. If one reads the debates on the 1995 Act, as I am sure you have, Mr. Griffiths—
As the hon. Gentleman knows, I have read that debate. He will be aware that my right hon. Friend the Member for Southampton, Itchen (Mr. Denham), who was on the 1995 Committee, asked the right hon. Member for Richmond, Yorks about an occupational pension scheme that had fallen short on wind-up. My right hon. Friend was assured that the right hon. Member for Richmond, Yorks did not anticipate that sort of loss being incurred once the minimum funding requirement had been introduced.
If I may, I shall develop a bit further my comments on how it was envisaged that the MFR would work in such cases, and where it has perhaps turned out to be lacking. It is important to recognise that, at the time, no one suggested that there was a 100 per cent. successful safety net, or that the MFR would provide complete security for pension savers. At that time, 78 per cent. of a typical 40-year-old's benefit would have been covered by contributions at MFR level but, of course, the landscape was very different. I served on the Committee in 1995 and, as we were in government, our party's Back Benchers were not particularly encouraged to say a great deal. There is a much more liberal, relaxed and laissez-faire regime now, of course.
Due to programming, and the steamroller that is a Government who—at the moment, anyway—have a large majority. However, I notice that one or two hon. Members have not taken the opportunity to share their views on the Bill with us.
A typical 40-year-old would have had 78 per cent. of their benefit covered at MFR level, but most schemes had surpluses. As I said, the landscape was very different in 1995; there were post-Maxwell issues, and all the resulting complexity and difficulty, to deal with. At the time, the issue was schemes having surpluses, and companies taking contribution holidays. That was very much the flavour of the time. Very few schemes wound up with shortfalls, although I do not say that none of them did. How times have changed!
Does the hon. Gentleman agree that one of the problems with companies taking pensions holidays—in some cases they were forced to—was that they often argued that they should do so because, when times got bad, they would be called upon to fund the scheme? Was that not partly why the issues have arisen?
I would not disagree. If one looks at the American experience, one sees that companies have a disincentive to top up their pension fund in good times. That was one of the issues put to me when I visited the Pension Benefit Guaranty Corporation in Washington. Other countries, such as Holland and Germany, approach the matter quite differently: they just have extremely tight funding requirements—to the extent that funds are, if anything, over-funded at most times. At least then there is minimal risk of the problems with which the hon. Member for Cardiff, West has been associated in relation to his constituency.
Then times changed. Between March 1997 and December 1998 interest rates fell sharply, and 20-year gilt yields almost halved, falling from 7.6 per cent. to 4.4 per cent. The problems of securing annuities for pensioners and deferred pensioners have made things more expensive; but, to make matters worse, apart from that, the Government have twice cut the rules and requirements for MFR. It was cut by 10 per cent. in June 1998, and by another 8 per cent. in 2002.
The stark result of that and other factors—I think it was the Americans who coined the phrase ''the perfect storm'' in relation to pensions—was that the test devised in 1995 can lead to members who have not retired getting significantly less than they expect when a scheme winds up. Today's weaker MFR, after the two reductions that I mentioned, would give a typical 40-year-old only about 20 per cent. of their benefit.
That is an interesting analysis, and one which the hon. Member for Havant (Mr. Willetts) brought before the House some weeks ago. He made the contrast between the typical 40-year-old then and now. The hon. Member for Eastbourne (Mr. Waterson) mentioned the two regulatory changes to the MFR and all the other things going on at the same time. Does he think that those two regulatory changes—which, as far as I am aware, his party did not oppose at the time—contributed to all, part or
very little of that change? How far does he think that the change was due to the other things going on at that time?
I do not claim to be such a pensions expert as to be able to answer that question but, as I have conceded, a variety of different factors were at work. The one thing that one can argue with a clear conscience is that those changes to MFR would not have helped. I was not doing this job then, so I cannot recall what my party's attitude to those reductions was, or what the attitude of the Liberal Democrats was—assuming that they had one. One has to see it all against a background of continuing criticism and carping from the industry. It felt that the concept of the MFR was unhelpful, and that it was an example of the law of unintended consequences—a constant theme in pensions legislation—and there was a strong feeling that it should be replaced with something. I will discuss the something shortly. I have no doubt that given all those factors, those two reductions in the MFR have significantly helped to weaken the guarantees given at the time of the 1995 legislation.
This is where I become even more critical of the Government. They have plainly known since 1998 that the MFR needed to be updated, replaced or changed in some way. They have been consulting with the industry about replacing it for four years. They are still consulting on the details and are proposing to carry on doing so. At the same time, as we know, companies are still going bust and members are continuing to lose their pensions. Later, we shall debate in inordinate detail the pension protection fund. All this is designed to be in place by April 2005 and I hope that in the Minister's winding-up speech he will share with us how confident he is that that timetable can be met. I think that he described it as a very challenging time scale and it would be interesting to hear whether that adjective still applied.
There has been a consistent delay in taking action. The Myners report of March 2001 made a series of recommendations, including the MFR's abolition and its replacement with a scheme-specific approach of the sort that is in the Bill. It reached the conclusion that the MFR distorted investment patterns without providing effective protection for members of defined benefit pension schemes, which many industry representatives had been saying for some time. It went on to say that it had distorted investment choices. In March of the same year, the Chancellor announced that he had accepted the recommendations and would be scrapping the MFR. That month, a joint Department of Social Security/Treasury document, ''Security for Occupational Pensions: The Government's Proposals'' was published. Lo and behold, in September that year, a further consultation document was produced, entitled ''The Minimum Funding Requirement: The next stage of reform''. There was considerable further consultation.
One thing that the Government did was to introduce the Occupational Pension Schemes (Minimum Funding Requirement and Miscellaneous Amendments) Regulations 2002. Then we had the pensions Green Paper in 2002 and the pensions White
Paper in June 2003. That confirmed what we already knew—that the Government intended to replace the MFR with more flexible scheme-specific funding requirements. Interestingly, the change was put forward as a way of reducing the burden on employers who wanted to provide defined benefit schemes. I will return to the question of cost a little later.
It is fair to say that the change, which was long overdue, has been generally welcomed. The CBI said that it welcomed the replacement of the MFR with a new scheme-specific funding requirement. It expressed a concern that there must be no clash between the Bill and the European pensions directive. As far as one can tell from as little detail as is in the Bill, there seems to have been an attempt to harmonise those two pieces of legislation.
I shall also refer to the comments made by the Association of Consulting Actuaries. It is something of a tribute to the Government that they have brought out of their shell the normally retiring folk in the actuarial profession. We read in the paper that the four most important actuaries in the country—people of considerable importance—have written to the Secretary of State expressing their serious concerns about the Bill. We shall have a more detailed discussion about their reservations when we discuss the PPF.
In its original briefing, the Association of Consulting Actuaries states:
''There are growing concerns about the scheme specific funding standard that is to replace the minimum funding requirement.''
It remarks that there are concerns that
''the detail, in order to meet the EU Pension Directive 'requirements', could be just as or even more onerous than the MFR when it emerges at a later date via regulation and guidance''.
It also makes the point that I have made—clearly, with little effect—that Ministers should
''give a commitment to reveal greater details of how the scheme specific standard will work during the Committee Stage of the Bill and before this measure passes into legislation.
In particular, sponsoring employers need to be satisfied that the new funding requirement will allow greater flexibility rather than, as is feared, a provision that is more onerous than MFR and will limit flexibility on managing the funding position. If the new regime turns out to be more onerous, then—again—employers will 'vote with their feet' in terms of the pension provision offered into the future.''
There is an issue that has been raised in a number of contexts in Committee; will the Government—unintentionally—make it less likely that employers will start new defined benefit schemes or keep existing ones open? I should be interested to hear the Minister's view on that.
I turn to the important topic of the interaction between this provision on funding and the proposed pension protection fund. There is concern about how they will work together. Mr. Kandarian, the former head of the Pension Benefit Guaranty Corporation, raised an issue with me when I was in Washington. As he saw the problem in America, two things needed to be addressed; first, the funding rules are not sufficiently onerous to ensure that most schemes will not get into difficulties when times are hard, and secondly, there is a tax disincentive for companies in
the United States to top up their funds when times are good. I have mentioned that disincentive; it is a specifically American problem, which they must address. It is perhaps ironic that, having received that advice from Mr. Kandarian as the outgoing head of the PBGC, the Senate recently passed legislation to relax the rules that he said were not ensuring sufficient funding for corporate pension schemes.
I seek guidance from the hon. Gentleman on something that I wrestle with. On one hand, he says that the actuaries are worried that the new scheme-specific funding requirement will be too tough—that it will be tougher even than the MFR and that it will kill off defined benefit. On the other hand, he quoted Mr. Kandarian highlighting the problem that the funding requirement was not tough enough and that that left insurance schemes vulnerable. Is the hon. Gentleman saying that the MFR needs to be toughened up to protect the PPF or relaxed so that we have more DB schemes?
I am not necessarily saying either of those things. A lot of the detail of what the Government intend to do is not in the Bill, and it would be presumptuous of me to go further than they are prepared to go at present.
There is a question about to what extent one needs a Pension Benefit Guaranty Corporation equivalent—a pension protection fund to act as a safety net—if one gets the funding requirements right. The Government have decided to go down a particular avenue and we broadly support their approach. In answer to the hon. Gentleman's question, a balance must be struck. We fear that because of other unintended consequences in the legislation and the problem, to which we shall return, of not starting from day one with a risk-based levy, the new protection fund will, as I said on Second Reading, be vulnerable in its early years, particularly if the Government do not get right the detail of the scheme-specific funding requirements.
I return to Steve Kandarian, who said:
''The biggest single thing that needs to be addressed is that employers need to fund (pension schemes) properly.''
Clearly, this is a problem now in America, as it was in 1995 in this country. He criticised contributions holidays in the USA in his final speech to the corporation, saying:
''The only alternative to tough funding rules is to charge painfully high premiums to the corporate sponsors of pension schemes or to shift the cost of a possible bail-out to taxpayers. 'There is no free lunch' ''.
Just like that. There is nothing like recycling such expressions.
In saying that, does not Steve Kandarian put his finger on the nub of the Bill? If there are not proper tough funding requirements there will be inordinate pressure on the protection fund in its early years. We should remember that in America, as I understand it, no benefits were paid for four or five years after the
fund at the guarantee corporation was set up following the collapse of the Studebaker car company. There is not even the option of charging what Steve Kandarian calls ''painfully high premiums''; the United Kingdom Government have set their face against doing that because they are not in a position to set the risk-based levy at the beginning. I shall deal with that again. Most people recognise that it could take several years in practice to sort out that matter.
Then there is the issue of whether the taxpayer stands behind that. We shall debate that in future, but we begin to see that a domino effect could develop if one were not careful. Other people closer to home than Mr. Kandarian have made similar points about the interaction between the PPF and the scheme-specific funding system. The Society of Pension Consultants has also pointed to the link between the risk-based premiums and scheme funding standards. Paragraph 3.2.4 of the regulatory impact assessment says that
''schemes which are over 100% funded relative to the PPF level of compensation, will not have to pay a risk-based premium.''
Might not that encourage employers to use this funding standard as their own funding standard? What will concern the finance director of a big company, when looking at the bottom line, is whether the company will be able to get out of paying the risk-based premium. We have already seen that one big company, Marks and Spencer, is looking for a way to avoid altogether—or at least to some extent—the risk-based levy by having a bond issue of some £400 million to raise funds for the black hole in its pension fund.
The Society of Pension Consultants says:
''There is also tension between the proposal for risk based premiums and the government's intention to replace the minimum funding requirement by a scheme specific funding standard.''
Deborah Cooper, who is a senior research actuary at Mercer's, the well-known company, says that
'' 'there is a very real possibility that the risk adjusted premium to the PPF will become a de facto benchmark, replacing the MFR and effectively outweighing the SSF in the minds of trustees and sponsors' ''.
I should be interested to hear the Minister's thoughts on that, because if the interaction between these concepts within the legislation cannot be got right, we will face some significant problems down the road.
It is axiomatic that the Government are trying to tread a careful line between providing the protection that the pension schemes and their members deserve and not producing an excessive burden of regulation and cost that will deter employers in the way that I have described from continuing to sponsor schemes and sponsoring new ones. That is the trick that the Bill must pull off if it is to be remotely successful.
The Bill's regulatory impact assessment, which is extremely interesting, says that the annual administrative costs of maintaining a statement of funding principles, compiling annual funding statements and producing inter-valuation reports will outweigh the savings of producing MFR valuations by £16.75 million. It is worth remembering that the assumption made about savings is that people will switch a proportion—in this case, 5 per cent.—of their
investments from gilts to equities, and that that will yield an additional 2 per cent. rate of return—the RIA makes some amazing assumptions about returns on equities, but that is a different matter. According to paragraph 4.1.15 of the RIA, that switch is assumed to increase investment returns by about £100 million a year.
Christine Farnish, the chief executive of the National Association of Pension Funds, says:
''We have deep reservations about the assumptions made. There is by no means any guarantee that funds will shift from bonds to equities, in fact there is evidence to suggest the opposite is happening.''
As with all such documents, the RIA is only as good as its assumptions. In this case, the assumptions are somewhat suspect. I should be interested to hear the Minister comment on that.
I shall make a final point on cost and member security. It was interesting that in its response to the December 2002 Green Paper, the Office of the Pensions Advisory Service made the point that scheme-specific funding is not a minimum funding requirement or a standard, but a return to the situation before MFR was introduced. It said:
''If employees are to be persuaded to join company final salary schemes they must have confidence that the employer is properly funding it. Whatever the demerits of the MFR system, it did at least impose some minimum standards on employers. The new proposal for scheme specific funding requirements does not.''
It would be difficult for any of us to argue for or against that view, because we—that includes the industry, the actuarial profession and everyone else—have yet to see the details of the new proposal. To put it mildly, it is worrying that OPAS should be taking such a negative view of the provision.
There are all sorts of more detailed points to be made later in the debate, but I have highlighted the big arguments that need to be resolved if the new concept of the funding requirement is to work.
I want to make two or three observations about clause 179, which sets up the scheme-specific funding requirement. It is appropriate to have the substantive debate at this juncture.
The hon. Gentleman rightly says that one of the key issues is the relationship between the scheme-specific funding requirement and the PPF funding rules. We do not want schemes to try to satisfy different funding rules at the same time in a conflicting, burdensome or onerous way. We do not want one set of incentives arising from one funding requirement that applies one investment strategy alongside different incentives from a different pressure source that applies a different investment strategy. That would place funds in a difficult position.
Each scheme will have its own agreed funding requirement, which will presumably reflect things such as the split of deferred and retired members and actives, the weight structure of the firm, its existing assets and its future liabilities. Will the PPF's risk-based levy be based on the extent to which the fund falls short of its scheme-specific funding requirement? In other words, will the risk-based levy be scheme-specific or will the pension protection fund have its
own definition of a deficit and then work out its levy on that basis? If that is how it will work, and it probably is, we shall have two different definitions of deficit—scheme-specific deficit relative to its scheme-specific funding requirement and a pension protection fund assessment of the extent to which the scheme would, if it were wound up, place a burden on the fund.
There is no reason why those two definitions should amount to the same thing. As the hon. Gentleman queried, will schemes pay more attention to one than the other? Will they be worried about not paying the risk-based premium because there is a financial penalty attached to it? Therefore, will that be the first thing they look at to ensure that they are not a burden on the PPF when they wind up? Will they then look at the scheme-specific funding requirement separately and try to satisfy two different things at the same time? How will the definitions inter-react? Is there a double regulation? That is my central question.
I absolutely agree with the hon. Gentleman. Does he agree that, if there are two different measures of compliance and one has a choice, the one upon which a company will quite legitimately and commercially focus is that which decides how much levy it will pay?
The hon. Gentleman has raised an important question about clarification. He implies, and OPAS seems to imply, that a scheme-specific funding requirement is to some extent discretionary and there is some element of choice. That is not my reading of the Bill. If the clause says:
''Every scheme is subject to a requirement . . . it must have sufficient and appropriate assets'',
I do not understand why OPAS would say that it is optional. Clearly, there is a menu for constructing funding requirements, and there must be an agreement between the trustees and the employer about them, but I do not get the impression that there would be any opt-out option. My worry is about the contrary—that there would be a double burden, a double regulatory responsibility. There would be certification to the scheme that it satisfied the scheme-specific funding requirement, but the regulator, and the PPF perhaps acting through the regulator, would also ask for information to ensure that the assets and liabilities satisfied a different set of criteria. Will the Minister clarify how the two will inter-react?
Clause 179 has its origins in the EU directive to which the Minister referred when talking to clause 178. Clause 179 uses the phrase ''technical provisions''. In the EU directive, the term requires pension schemes to have
''at all times sufficient and appropriate assets to cover the technical provisions''.
That sounds like a 100 per cent. funding requirement. One must have the assets to cover one's technical provisions—loosely, one's liabilities.
Later clauses talk about recovery plans. Thus it is recognised that one cannot just look at a scheme to tell whether it is fully funded; one must do a complex actuarial calculation and assessment of assets and liabilities, to which the answer might be, ''It is not.''
One does not then say, ''They have broken the law; we lock them up.'' One says, ''They are not satisfying section 179, so we shall put in place a recovery programme.''
In the words of the directive, the Bill says that a scheme needs enough money to cover its technical provisions. However, the Bill also has a recovery process for circumstances in which a scheme does not have enough money. How lax could that recovery process be and still allow Britain to satisfy its obligation under the EU directive? The directive will be introduced in 2005, if I remember rightly, and we shall be party to it. It will require us to require of occupational pension funds that they have the assets necessary to meet their technical provisions. We also accept that there will be schemes that do not manage that. By regulation, we shall allow a structure for recovery. What I am not sure about is whether the EU directive provides for the concept of a recovery period. Will there by any stipulation in the directive that schemes must meet the conditions within so many years of failing to do so? Is that what will accompany the regulations that we have not yet seen? How far will they be driven by what the EU directive eventually stipulates? There are a series of questions that relate to that issue.
If I remember rightly, the EU directive says that funds shall have the money to meet their technical provision at all times. How can it be that funds have the money at all times, when a later clause mentions recovery plans? That clause clearly implies that they do not have the money at all times. That is my second issue.
My third and final issue is about whether the changes are more or less of a burden. The regulatory impact assessment says that firms are switching to equities, which have higher returns, so that is £100 million extra. To borrow Mr. Kandarian's phrase, that sounds like a free lunch. It seems to suggest that if schemes put more money into equities, they will have more money in their funds and will gain a free £100 million.
One's initial reaction to that is that if it is a free lunch, why do funds not do it anyway? If they can get an extra £100 million, why do they not? The Minister's argument is that they cannot because of the MFR. However, once that has gone, why stop at 2 per cent.? If they can have £100 million free, why not put 4 per cent. of their assets into equities and have £200 million free or 6 per cent. and have £300 million free? The answer, of course, is that there is a risk attached to that strategy, which is not reflected in the regulatory impact assessment. Are the Government right to claim the win without counting the hit? There is an uncertainty attached to the £100 million. It could become minus £100 million. The Government are wrong to claim the full benefit of the enhanced return without recognising that there is a risk and an uncertainty attached to that. Is it standard practice to claim uncertain gains in a regulatory impact assessment when, in any given year, schemes could do worse by shifting into equities? As
we know, some schemes are shifting out of equities for that reason.
On the face of it, it seems to make sense that schemes have a funding requirement that fits their characteristics. In a world where there is also a pension protection fund that does things differently, my concern is that we may end up with schemes having to try to do two different things and, possibly, being pulled in different directions. Potentially they may be doubly regulated. Pendulums have a knack of doing what pendulums do and perhaps we have swung back to the other extreme. We were worried that MFR was not giving enough protection, so we have gilded the lily by having a scheme-specific funding requirement and a risk-based levy and PPF scheme, both of which try to do similar things, possibly in different ways. I wonder whether the Minister can reassure us on that.
As I rise for the first time in this Committee, may I say what a pleasure it is to serve under you, Mr. Griffiths?
I have a brief point to make to the Minister. I simply query the wording in clause 179(1), namely that every scheme should have ''sufficient and appropriate assets''. I wonder what exactly that means. My hon. Friend the Member for Eastbourne referred to the great change that has taken place in pension schemes since 1995. That is a change in the valuation and performance of the assets held in those schemes. In the years since 1995, we have seen a dramatic underperformance and a fall, in real terms, of the UK stock market. It has been a massive underperformance compared with other major indices around the world. In the eight years prior to 1995, we saw a significant recovery from the crash of 1987 and a year-on-year outperformance by the major UK indices of other indices around the world with which they are often compared. If appropriate assets include equities, what view does the Minister take of the volatility of equities and their ability to fluctuate daily, let alone yearly? How will he measure that over the longer-term life of the scheme?
Is my hon. Friend aware that the American model for the protection fund—the Pension Benefit Guaranty Corporation—has changed its investment policy away from equities to gilts and other fixed-income investments? Given the $11.5 billion deficit, does he share my concern that that might not be precisely the right moment to be moving in that direction?
I was not aware of that, but I am now. I learn something new whenever I sit with my colleague and his point was well made. If the pensions industry is ever to dig its way out of the terrible hole in which it finds itself, it will not do so by investing in the safest of all asset classes. The returns and long-term growth afforded by gilts and other fixed-income instruments will not provide the high returns that are the only realistic way in which pension funds can claw back some of the values that they enjoyed during the halcyon days of the 18 years of Conservative Government.
Pension funds in the past have gone up and they have come down, but they have always recovered. The
most depressing aspect under the Labour Administration is not the fact that they have fallen—what goes up can come down—but the low growth and no growth of a whole range of asset classes. It is much harder for investment managers to make a return in a low-inflation, low-growth economy and I query what the Minister means by appropriate assets and how he sees the fund managers—it will be their job to oversee the much-needed growth in funds—having the leeway to get the necessary returns rather than just putting money into gilts and fixed-income investments. I should be grateful for his comments on that.
I enjoyed the first contribution by the hon. Member for Bexhill and Battle (Gregory Barker), but the fetish with laissez-faire got us into the present pensions mess. We are discussing the former minimum funding requirement and scheme-specific funding for pensions and we should always think about scheme members when designing provisions. The purpose of the clause and the Bill is to provide ultimate security for scheme members. The minimum funding requirement failed to do that. When workers found that their pension companies had become insolvent and that their pensions were not worth the paper they were written on and certainly not worth the promises that they had been given, they were puzzled. Having done their research, they discovered that there was such a thing as the minimum funding requirement and believed that the words ''minimum funding requirement'' in an Act of Parliament meant that and that their pension fund was funded to the minimal level to ensure that their benefits were protected.
I was a trustee of a local authority pension scheme, which was, fortunately, backed by the taxpayer so we did not have to worry about whether we got it wrong, although we took it seriously. I remember advisers telling us that we should expose the fund to more equity risk because we were turning down marvellous returns and one-way bets, and that, in the long term, over a 70-year cycle, equities would produce the best returns of all, and we should get out of property and gilts.
The hon. Gentleman describes a classic case of what is called moral hazard. He and his fellow trustees felt able to be a bit more adventurous—as far as that word can be used in the context of pensions—because they knew that they had a Government safety net. Does he believe that the Government should stand behind the pension protection fund?
It was not a case of moral hazard for two reasons. First, we would not take the immoral option of handing over the responsibility to the taxpayer, and secondly, it was in our own interest not to do so because we had to stand for re-election as councillors at some point in the future. There was no question of our doing that. Nevertheless, it is true that people in the public sector in those types of final salary schemes have those schemes underwritten by the taxpayer. Clearly, given that that is not the case in the private sector, the pension promise has to be given reality through the laws introduced by the state. I think that we have all agreed that the minimum
funding requirement abjectly failed to provide the protection that people were led to expect, notwithstanding the hon. Gentleman's quotation from comments made by the right hon. Member for Richmond, Yorks during proceedings on the Pensions Act 1995.
Ultimately, the technical question of whether the Government should stand behind the fund is not what is most important. The Government stand behind the entire private banking sector as lender of last resort. If it were not for the fact that the Government, as lender of last resort, guarantee the entire financial system in this country, the private sector banking would collapse. If a laissez-faire policy were adopted and the sector were left to the free market, it could not work because, as we all know, it is built on a credit bubble and if confidence in that were lost, the whole system would collapse. I am waiting for the hon. Member for Eastbourne to dispute my little lesson, but he is choosing not to do so at this point.
We need to get things technically right.
The hon. Gentleman has provoked me again. I do not disagree with him. He is quite right that there are already circumstances—he mentioned banking—in which the state stands behind the system. However, he has not quite answered my earlier question about whether he believes in this context that the PPF should be underpinned by a Treasury guarantee.
I hope that that will not be necessary, but it is my personal view that if the whole system came under such pressure that it was unable to meet its requirement, the state would have a responsibility. If we consider the situation in the United States—I know that the hon. Gentleman knows a lot about this—where the Pension Benefit Guaranty Corporation perhaps has a much closer relationship with the Government than is planned in this country, we can see that ultimately that probably is the case there. However, I understand the Government's reasons for not wanting to include a provision of that sort in the Bill. They are the very moral hazard reasons that the hon. Gentleman raised with me earlier.
If the hon. Gentleman anticipates that there are circumstances in which the Treasury could assume this potentially huge and unlimited liability, does he anticipate that national insurance contributions would have to rise to guard against that?
Not in the least, because that is not what I said. I said that I could understand why the Government had not made that commitment—for the moral hazard reasons mentioned earlier. If we follow the hon. Gentleman's argument to its logical conclusion, the Government's guarantee as lender of last resort to the banking system would have to be underwritten by a massive increase in national insurance. That has not happened, because everyone knows it will not be necessary, because we will maintain confidence in the system. If we build the confidence that is necessary—that is what we have to do in the occupational pension system—there will be
no need for the Government or anyone else to act as a guarantor of last resort.
What workers and scheme members are looking for from the Bill is probably not for us to tell them exactly how things will work, although that is very important. They want to know that the pension promise that they are given is just that: a promise, not a false promise as it has turned out to be in the past. They want the Bill to guarantee that, if a company becomes insolvent and has promised workers a pension based on their final salary, up to 90 per cent. of the pension's value will be protected in the case of active pensioner members. That is the key point.
What is most important is not that rigid handcuffs are put on scheme trustees who are trying to attain that objective, but that people are assured that the pensions regulator and others are keeping a close eye on what is done to pension schemes, and, ultimately, that workers are confident that their benefits will be protected.
We have had a good, general and, at times, technical discussion about this and other clauses, and, indeed, about other parts of the Bill. I will try not to be persuaded to go into too much detail about the pension protection fund, but I listened with great care to what my hon. Friend said on a range of issues.
This part of what is a complex and technical Bill could claim to be top of the pops when it comes to complexity. The seemingly simple question of how we adequately fund a pension scheme brings to mind a range of sub-questions relating to adequacy, the scheme and so on. The issue is difficult. I notice the hon. Member for Eastbourne grinning. We all sit at his feet when it comes to learning, but although I learned much from him about what other people say about the provisions—some think them too strict, others too lax—I do not know whether he thinks them too tough. Doubtless there will be an opportunity for him to draw together and synthesise the analyses that he presented to us and give his own view, although not necessarily now.
The clause requires schemes to satisfy a statutory funding objective. That requires it to have sufficient and appropriate assets to cover its technical provisions. The term ''technical provisions'' is taken from the European pensions directive. It is defined in the clause as
''the amount required, on an actuarial calculation, to make provision for the scheme's liabilities.''
In plain English, that means the amount that a scheme needs to hold now, on the basis of the actuarial method and assumptions used, to meet its pension commitments as they fall due in the future. That is a critical phrase. The clause sets out the broad framework and the key elements involved in the actuarial valuation of a scheme, its assets, liabilities and technical provisions.
Perhaps I could come to that later. The concept of scheme-specific funding means that those questions would be tested against the nature of the scheme, so there is no general answer. It would, for example, depend on the age profile of the members.
I will not keep complaining about this, but clearly the details of how the assets and liabilities are to be calculated will be laid down in regulations and actuarial guidance. I think we are clear about that. However, according to the Library brief, there will be
''alternative methods, and scheme trustees or managers will be able to choose the method most appropriate to their scheme.''
Will the Minister at some point set out those alternative methods?
I will try to cover that either now or when we address later provisions.
Subsection (3) provides for regulations to specify the detailed requirements for how these calculations will be carried out by the scheme actuary. Scheme trustees will play a greatly enhanced role in the operation of the schemes and the new funding requirements. Regulations under subsection (4) will require them to determine what methods and assumptions the actuary will use when calculating the scheme's technical provisions. They will also require that, in doing so, the trustees will need to follow prescribed principles. Those principles will reflect the provisions of the EU pensions directive and will require actuarial calculations to use assumptions on relevant factors, such as investment returns and life expectancy of scheme members, that have been chosen prudently.
It strikes me that a third funding requirement is lurking: accountancy standards. The Minister is reading out the terms of the EU directive that will feed into the scheme-specific requirement, which is one way of valuing assets and liabilities. The PPF is a second way. Is he happy that either of them relates to the accountancy profession's Europe-wide decisions? Finance directors may be driven to deal with how they present their scheme funds in the annual accounts. That would be a third driver with regard to the mix of assets and liabilities and funding pressures. Is he confident that we have not merely got three different pressures at work at the same time?
The issue of over-regulation has been raised. However, I stick to the point that we can establish broad principles and criteria in the Bill, but we need to work them up with the relevant professionals in order to get things right. Ultimately, the scheme actuaries must satisfy themselves that professional standards are being kept to. The hon. Gentleman is right to say that there are different approaches to the difficult question of how to fund pension schemes adequately. I have come across more than three of them.
Within the parameters that I was describing, the trustees will have considerable flexibility to develop a
scheme-specific funding strategy that reflects the circumstances of their particular scheme. They will be able to take account of factors, such as the age profile of the scheme's members and the balance between active and retired members, which will vary from scheme to scheme. A one-size-fits-all funding requirement is inappropriate. Other relevant matters will include the employer's policy on future salary increases, expected staff turnover, life expectancy and the trustees' investment policy.
I will do my best to answer some specific questions. If I do not have sufficient technical expertise to do so, I hope that Committee members will think it appropriate for me to write to them. The hon. Member for Eastbourne asked a range of questions. The minimum funding requirement came into force only in April 1997. It might not matter too much, but I was unsure whether the hon. Gentleman was defending the MFR or was a principled critic of it.
Yes, but at different stages.
The hon. Member for Eastbourne indicated that the MFR was running into difficulties as early as 1998. I do not want to be partisan by wondering aloud why it ran into difficulties so soon after it was passed by a previous Administration.
Political historians will agree that April 1997 was pretty early on for the blame to lie with the new Labour Government. If that is where the blame lies, it was prescient of that new Government to run into difficulties before they were elected.
I was only trying to make the point that the Minister's Government took the view—rightly or wrongly—as early as 1998 that something needed to be done, and not long thereafter they were clear about what they intended to do, but it has taken until March 2004 for us to get around to doing it. Why has it taken so long?
I have a subsidiary point. The Minister made the interesting observation that much of the Pensions Act 1995 came into force a year or two after it was enacted. The view was obviously taken that a challenging time scale was inappropriate. Does he think that there are lessons to be learned from the way in which the 1995 Act was introduced, not at a leisurely pace, but in a measured way to ensure that it was right?
The hon. Gentleman's theme of the day is having it both ways. He asks us why we have taken so long and then asks whether we should learn the lesson of acting in a measured way. Perhaps he will wrestle with those contradictions and give us a general answer on that later.
The MFR came into force in April 1997 and was subject to a phased introduction. Far from operating at a satisfactory level, it became clear fairly soon after its introduction that it had some serious structural problems, which led to the programme of review and consultation, culminating in the Government's announcement in May 2001 that they intended to replace it with scheme-specific funding arrangements.
It is right to say that that was widely welcomed by employers and the pensions industry. We have taken a measured approach in our consideration of the issues and in the consultation. Of course, we must always find a legislative slot, which explains much about the time scale.
The hon. Gentleman also asked why the Government have twice cut the value of the MFR, in 1998 and 2002. I am bound to say that this is a highly technical arena that concerns the actuarial basis for the MFR, which has, as he said, been adjusted twice. The relative strength of the MFR test is affected by a range of factors, including economics and demography and covering issues such as longevity, changes in yields from equities and other investments, which were mentioned, and changes in the costs of buying annuities and deferred annuities. Perhaps it is inevitable that such factors will change over time and, therefore, the strength of the MFR will fluctuate relative to prevailing market conditions.
The Faculty and Institute of Actuaries monitors the actuarial basis for the MFR, with a view to recommending changes when appropriate. That basis was adjusted in 1998 and 2002, following its recommendations, because the MFR was operating at a higher strength than originally intended. As I said, those changes represented technical adjustments, which were recommended by the actuarial profession and were intended to realign the MFR closer to the strength that was originally intended. They did not involve any change in policy regarding its strength.
These are profoundly difficult matters. Although one is occasionally tempted into partisanship, it is normally sensible to listen to what the actuarial profession advises.
As we all know, actuaries always get things right, including projections for longevity, which is one of the problems that we face now.
I have a technical, rather than a partisan, question. Does the Minister accept that if those two changes to the MFR had not been made, the people who have lost out on their pensions rights would have more to show for their contributions than they do now?
Hindsight is a wonderful thing. All I can say is that that was the recommendation of the Faculty and Institute of Actuaries at the time and it was sensible of the Government of the day to follow that advice. It all adds up to us—not just to the Government, but to others, too—thinking that we need to move ahead in a different direction, hence the proposals that we are discussing today about scheme-specific funding.
I was asked about timing. The new scheme funding requirements will come into force as soon as is practicable. However, a precise date has not yet been determined. We intend to have a transitional period to allow schemes to maintain the existing three-yearly valuation cycle if they wish to do so. The measure does not have to be introduced as early as April 2005. Its introduction in September 2005 would be in line with the European directive that is coming into force. We are considering that possibility.
In response to the line of questioning adopted by the hon. Member for Eastbourne, unlike the MFR, the new funding arrangements will allow individual schemes to adopt funding strategies and contribution levels appropriate to their specific circumstances. That is the burden of this issue. I said that one size does not fit all when it comes to pension schemes and their actuarial basis. I have indicated a range of factors, including staff turnover, which will need to inform scheme-specific funding.
The hon. Gentleman asked about what one might call moral hazard and whether we need a minimum funding standard to protect the PPF from abuse. He mentioned what he had learned in Washington. We are ensuring that rigorous safeguards are in place to protect it from abuse and to ensure that it has sufficient funds and that costs to the levy payer are minimised. For example, the regulator will have a range of new powers to take action aimed at resolving difficulties arising in a scheme's funding arrangements. Those include powers to impose a scheme of contributions. The PPF will be available for those members whose employers become insolvent if, for example, they have been unable to make up a deficit within the scheme.
The hon. Member for Northavon asked a range of questions. He was particularly interested in the distinction between PPF levels of funding and scheme-specific funding. The risk-based levy will be based on PPF levels of benefit, which we will discuss later. On the difference between that level of benefit and what benefits the scheme holds, a range of considerations come to mind. The scheme-funding provisions require trustees to have in place a funding strategy appropriate to their scheme. There will be no requirement to fund up to the PPF level. If we were to make that a requirement, it would be too general a provision and would run a coach and horses through the concept of scheme-specific funding.
The two concepts are different. That might make for some difficulty in hon. Members' minds—I am not making a point about the hon. Member for Northavon in particular—but this is a matter of horses for courses. It is perfectly appropriate for a scheme to fund up to the PPF level if it wants to, perhaps to avoid the risk-based levy. However, that is not the same as adequacy in terms of scheme-specific funding.
My broad recollection from our discussions about the regulator is that he keeps one eye on funds, which means ensuring that there is enough money in them, while keeping half the other eye on the pension protection fund. The Minister seems to be saying something slightly different: frankly, if the schemes do not fund up to the PPF level, what the heck? It seems that as long as they are satisfying the scheme-specific funding requirement, the regulator will not come knocking at their door. Which is it?
The regulator is as important as the PPF in ensuring that as few cases as possible need
to be salvaged by the new PPF. The new regulator has a range of powers to ensure that schemes are being run properly. Scheme-specific funding is a requirement that properly means that schemes have sufficient funds on an ongoing basis to meet pensions rights and liabilities. It is not the same—this is the burden of my remarks—as saying that the fund must be funded up to the PPF level in case everything has to be paid out at once. They are different concepts. I can understand that it appears confusing, but there is a logic and rationality to the two concepts.
I agree with the hon. Member for Northavon. The Minister is dealing with an important issue, and it will save time later on if we deal with it carefully. Can a scheme have its own scheme-specific objective and take all the relevant steps to meet it—meaning it is completely in the clear—but still end up not meeting the PPF requirements and paying a heavy risk-based levy? I wonder whether the industry has picked up on that in the various discussions on how the system will work. I thought of the two provisions as belt and braces, but it sounds as if one is gold-plating the PPF standard whereas the other is more of a basic standard.
As I said, we shall deal with PPF funding later, but the PPF funding measure will be based on the cost of buying out PPF-level benefits with an insurance company. That is how it will be measured. It should be relatively simple for schemes to perform that calculation because it will work according to a similar methodology to the full buy-out valuation of scheme benefits required by the actuarial profession. The funding measure is not a funding standard, and would not be an appropriate funding requirement for all schemes.
Part of the difficulty relates to what seems to be a simple question of how we can fund a pension scheme adequately. As I said, that leads to a host of sub-questions and difficulties. I was thinking about that yesterday. Although actuaries will say that the comparison is far too simplistic, it is like being asked about the mortgage liabilities on one's dwelling. How would we answer that if we had to move house tomorrow? One of my officials helpfully suggested, ''Minister, you would have to move if you lost the next general election.'' I am not sure where that official is based today.
If we needed to pay off our mortgages immediately, we would need a large amount of money. Calculating mortgage liabilities also involves working out what we need to pay out next month, in the year ahead and so on. We are talking about a high standard for PPF levels. With scheme-specific funding, we are talking about a standard that is based on ongoing liabilities. That is the difference.
I knew that I had seen it somewhere, as they say. Clause 5(1)(c)—the objectives of the regulator—states:
''to reduce the risk of situations arising which may lead to compensation being payable from the Pension Protection Fund''.
The Minister seems to be saying that as long as funds satisfy the requirements of clause 179—the scheme-specific funding requirement—the regulator will leave them alone because they can pay a risk-based premium if they are not funding up to PPF levels. However, clause 5(1)(c) states that part of the regulator's job is to reduce the risk of claims on the PPF. The regulator will come knocking on the door because that is part of his role. So the Bill refers to two separate regulations.
I see where the hon. Gentleman is coming from, but with respect, he is wrong. The regulator has to ensure that the pension scheme is run efficiently and competently, in many ways, and that the trustees are doing their job. If they are not, an independent team will be sent in—there will be inspection rights and so on. The scheme will be run at such a high standard that it will not have to be a customer of the PPF. That is not the same as saying that at all times every scheme has to have funds for PPF levels of benefits.
A scheme can fund up to scheme-specific funding levels, but as I said, that might be below the level required for PPF. Scheme-specific funding is appropriate to the scheme. The trustees might say to themselves, ''Yes, we can't suddenly pay out all the rights today should the thing crash, but we are satisfied that it is being adequately run on an ongoing basis and that it would meet the criteria for scheme-specific funding.'' The two concepts are different. If a scheme does crash—we hope that there will be few cases of that—the PPF will make sure that pension rights are honoured.
I found the Minister's mortgage analogy unhelpful. He is in danger of making the obvious complicated. If what he is saying is correct, my understanding is that both the PPF and the scheme-specific funding are designed to achieve one thing—and one thing only—which is that the money will exist to pay the liabilities throughout the life of the scheme. If the funding requirement is met—as it must be met for the specific scheme—it leaves an extraordinarily narrow risk on which to base the risk-based levy later, a point to which I shall return in detail. It seems that it would take almost an act of God to make a well run scheme that is fully endowed with assets suddenly crash. The Bill seems to be drafted in that way, but I might be wrong.
We shall discuss detailed PPF funding later, so perhaps we can return to the implications of the clause for the PPF. I was asked whether the European Union pensions directive requires the Bill to specify the period for schemes to make good a shortfall in fund. It allows schemes to be underfunded for a limited time, provided that they put in place a realisable and concrete recovery plan to make good the shortfall.
We do not believe that the directive requires the recovery period to be specified in legislation. Rigid
deficit correction periods were one of the main drawbacks of the MFR, leaving some employers to take a short-term approach to funding or even to close their schemes. However, it is clear that the directive does not envisage that the schemes should be permitted to remain indefinitely underfunded. To prevent that from happening, schemes will be required to file copies of their recovery plans with the regulator. If a recovery plan were then replaced with another, trustees will have to explain why to the regulator and to know whether the regulator can impose a time limit on recovery plans.
The hon. Member for Northavon said that the directive requires schemes to have at all times sufficient and appropriate assets to cover the technical provisions and whether that meant full buy-out. The directive does not require a scheme to be fully funded in the sense that it must at any time be able to buy and defer annuities to discharge all its crude liabilities immediately. That would be unrealistic and inappropriate for an ongoing scheme. The directive recognises that actuarial valuations may, of course, identify funding shortfalls and requires domestic schemes in that position to put in place a recovery plan for correcting the shortfall.
Does the Minister understand my confusion at the phrase ''at all times''? It cannot be true that schemes have sufficient funding at all times if there are also recovery mechanisms. Why are the Government happy with a directive that requires schemes at all times to have enough assets to meet their liabilities if we are not legislating for that?
The directive requires schemes ''at all times'' to have sufficient and appropriate assets to cover the technical provisions. I explained that ''technical provisions'' means funding adequately on an ongoing basis. As we know, such issues are difficult, but they are fundamental. The difference between a fund that would be required to be built up for anything approaching full buy-out could be, depending on the scheme, colossally larger, by a factor of many times, than what would be required on an ongoing basis. If we were tempted into anything that looked like a full buy-out for every scheme, there might be a stampede away from defined benefit schemes. That is one of the difficulties that we face. The Bill seeks to strike a balance between security and reasonableness in terms of how we fund pension schemes and of what we expect employers, among others, to fund.
I was asked about savings. It is assumed that private sector defined benefit schemes have £100 billion invested in gilts and UK corporate bonds. It is also assumed that 5 per cent.—£5 billion—of those investments will be switched to equities after the removal of the MFR and that, on average, an additional 2 per cent. interest a year will be achieved on those switch investments. That additional investment return will amount to £100 million a year. That is the basis of our calculation.
The hon. Member for Bexhill and Battle asked what assets it was appropriate for schemes to hold, and he
obviously was not expecting much by way of an answer because he has not stayed to hear it.
Touché. I am sure that he will be an avid reader of Hansard in the days to come.
It will be for trustees to determine what assets a scheme should hold. In doing so, they will have regard to the scheme's statement of investment principles and to matters such as the scheme's demographic profile, including the balance between younger members and those who have retired. It is not for me give advice, but a scheme with a relatively young age profile might have a very different investment strategy from one in which the great bulk of members were within 10 years of retirement age. The regulator's code of practice for trustees will cover the factors that they will need to consider in deciding what assets it is appropriate for the scheme to hold in order to meet its technical provisions.
I will not be tempted into commenting on the remarks made by the hon. Member for Bexhill and Battle about the halcyon days of Conservative rule. I will certainly not comment on them in his absence, save to say that people spoke of nothing else in Croydon's dole queues, although the words that they used in their critique were blunter than the word ''halcyon''.
The issue of actuarial methods and assumptions arose. Regulations will require trustees to choose the actuarial methodology and assumptions to be used in calculating their scheme's technical provisions. In doing so, trustees will need to obtain actuarial advice. It would, perhaps, not be useful to go into too much detail, but I can write to hon. Members who want more information.
I may, or may not, have covered all the very technical issues that have been raised, but I have done my best and shall write to hon. Members if I need to answer any other questions.
Question put and agreed to.
Clause 179 ordered to stand part of the Bill.